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The Macro Viewpoint - The ECB's inflation fight, Italian complications and the UK leadership race
21 Plays2 years ago
Fabio Balboni takes stock of the ECB's first rate rise in 11 years and the effectiveness of its anti-fragmentation risk measure for Italy. Liz Martins looks at what's next in the race to replace Boris Johnson as British prime minister. Disclaimer. To stay connected and to access free to view reports and videos from HSBC Global Research click here
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Introduction to HSBC Global Viewpoint Podcast
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Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends and opportunities.
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Make sure you're subscribed to stay up to date with new episodes.
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Thanks for listening.
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And now onto today's
Weekly Macro Viewpoint Overview
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show.
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You're listening to The Macro Viewpoint, our weekly look at key views coming from our team of economists and strategists here at HSBC Global Research.
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We recorded this podcast on the 21st of July.
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And of course, all of the associated disclosures and disclaimers must be viewed on the link attached to your media player.
ECB's Unprecedented Rate Hike
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Hello, I'm Piers Buttle in London and I'm joined by our managing editor, Elin van Dijn, on the line this week from Holland.
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We've just had the ECB raise interest rates by 50 basis points.
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It's the first increase in 11 years and double the increase telegraphed by the ECB.
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Our European economist, Fabio Balboni, will be joining us to review the rate increase.
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We've also had two political dramas unfolding this week, and they too have economic implications.
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Italian Prime Minister Mario Draghi says he's resigning.
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Fabio will no doubt have a view on that too.
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And in the UK, the race for a replacement for Conservative Prime Minister Boris Johnson is underway.
UK's Heatwave and Political Developments
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Senior economist Liz Martins joins us to look back at a week in which not only temperatures broke all the records.
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First, though, let's hear more about the ECB.
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Fabio, welcome to the podcast.
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Thank you.
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So 50 basis points, that was a bit of a shock.
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Yeah, well, indeed, it was a bit of a surprise.
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The ECB had told us very explicitly back in June that they would have raised rates by 25 basis points at the July meeting.
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Indeed, at the time, we thought it was unusual to be so explicit about something they would have only been able to deliver six weeks later.
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And under such
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a situation of economic uncertainty.
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Earlier in the week, there was some reports in the newswire suggesting that in fact, the ACB might have been willing to consider a larger rate rise.
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And we thought there were good reasons
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For one, inflation had been, again, surprising to the upside, raising to another all-time high of 8.6% in June in the eurozone.
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The euro has depreciated further, at some point hitting parity with the dollar, which will put further pressure on inflation in the future.
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So a bigger than expected rate rise could have helped tame some of those impression pressures and also
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shore up the euro a little bit.
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So the ECB delivered on that.
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In the end, it came down to the credibility of their forward guidance provided back in June against the risk of lagging further behind in tackling inflation.
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And then they decided for a more aggressive mood.
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And indeed, as a result of that, they also decided to drop rates guidance altogether.
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They didn't tell us anything about what they intend to do in September.
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And we now, however, still expect that the ECB will deliver a 50 basis point rise in September, given that we think that inflation could again surprise to the upside in the summer.
ECB's Transmission Protection Instrument
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And we also saw the approval of the transmission protection instrument.
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What's the background to that?
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Well, the background to that is that we've seen increasing risk of market fragmentation across the eurozone since the ECB effectively signaled its willingness to tighten monetary policy and even more so since the ECB ended all asset purchases.
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So, of course, with widening
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spread at some point in mid-June, we saw the spread of the 10-year Italian sovereign bonds against the Boone rising to over 250 basis point.
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It becomes very difficult for the ECB to be able to deliver on those rate rises because monetary conditions are already tightening very fast in periphery countries.
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So tackling and being able to limit spread widening is a key precondition for the ECB to be able to
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increased rates.
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In mid-June, they had already started to tackle the problem by allowing reinvestments under PEP to be redeployed flexibly across jurisdictions.
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And we've seen that tool been implemented since the 1st of July.
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But that's not enough.
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So today the ECB announced a new tool, the transmission protection instrument, which in theory should give the ECB unlimited power to be able to protect the transmission mechanism across all jurisdictions and therefore reduce the risk of fragmentation in the future.
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And how will it work in practice?
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Well, there are still many open questions.
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Some details were revealed today.
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Some were left unsaid, as Christine Lagarde put in the meeting.
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So, as I said, it should be an unlimited tool.
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It will have the ability to purchase assets under any jurisdiction, but with some conditions.
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Those conditions are relating particularly to four issues.
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One is that a country has to meet European fiscal rules.
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Two is that a country should not have excessive macro imbalances.
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Three is that a country should be in line with their own track, rather, with the implementation of the recovery and resilience plan under the Next Generation Youth Fund.
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And fourth, that there should be a positive depth sustainability analysis.
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And in any case, the final judgment will be made by the governing
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Council, and here the most important issue is being able to distinguish what is an unwarranted widening of the spread as opposed to a warranted widening of the spread.
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The ECB would only be able to intervene in case there is the former, but if instead a spread widening is due because of underlying fiscal issues, for instance, then the ECB would not be able to intervene.
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So in any case, this is for us an example of creative ambiguity by the ECB.
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So the ECB is hoping by announcing large enough numbers and a very complex series of conditions under which such instrument will be able to deploy that the market will not be willing to test it.
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But we suspect that indeed the market might question the ability of the ECB to intervene, particularly considering
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during what has happened in recent weeks in Italy with the ongoing political instability and some of the widening of the spreads that we have seen there.
Italy's Political and Economic Challenges
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In that respect, we've just seen the Prime Minister Mario Draghi resign today.
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What's the outlook for the country after that?
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Well, absolutely.
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This was a very surprising turn of events.
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Italy looks at to have elections at the end of the normal term, next spring.
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But things unraveled pretty quickly.
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The Mario Draghi government lost the support of key allies, and then the prime minister resigned earlier today, and later on the president dissolved parliament.
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So Italy will now have elections
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early election on 25th of September.
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So obviously that creates a situation of political stability against the backdrop of significant challenges already facing the country with economic growth slowing, significant energy crisis.
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Italy's hit particularly
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hardest by the slower flow of gas from Russia, given its high reliance on Russian gas imports, and also a difficult fiscal situation, of course, with a very high debt GDP level in excess of 150 percent resulting from the pandemic.
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So the situation of political uncertainty in early election leaves the country in a difficult situation.
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There are some immediate implications, such as, for example, that even a new government should not be able to agree a budget in time before the end of the year.
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There are some important deadlines under the recovery and resilience plans to unlock the next 19 billion euro payments to be met by
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the end of the year that most likely at this stage will be missed.
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And therefore, as I said, this also has implication for the ECB because it could make it very hard for the ECB to gauge that the recent widening of the Italian spreads
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that we have seen is indeed warranted, as at least a part of it seems related to rising political risk and some underlying challenging facing the economy.
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And as a result of that, it seems unlikely that the ACB will be able to...
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use these new tools to counter the recent spread widening.
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And as a result of that, we can continue to see a situation of tensions in the sovereign bond market lasting through the summer and in all likelihood until the elections will take place.
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On certain times ahead.
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Fabio, thank you very much for joining us.
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Thank you.
UK's Economic Situation and Leadership Race
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So we turn to the UK now, where this week inflation is surging, real wages are declining, and the UK's ruling party is searching for a new leader after the resignation recently of Prime Minister Boris Johnson.
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Our senior economist Liz Martins joins us to help make sense of it all.
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Liz, welcome.
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Thank you.
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So let's start with the inflation rate and the impact on real wages.
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Yeah, so this week we have the inflation number for June, which was 9.4% year on year for the CPI measure.
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That's a fresh 40 year high within that food price inflation was up 9.8% year on year and household energy bills up 70% year on year.
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And that really reflects soaring wholesale gas prices and the moves we've seen in commodities.
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So more record breaking stuff on inflation and wages aren't keeping pace.
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So we also had the labour market data that was for May.
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And that showed at least on the regular pay measure, so excluding bonuses in real terms, pay fell by 2.8%.
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And that was the biggest fall on record.
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So consumers in the UK really are being squeezed at the moment.
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And Liz, what does that backdrop mean for the Bank of England?
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Well, we know the Bank of England is going to raise interest rates again at their meeting on the 4th of August.
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The question now is whether they raise by 25 basis points, as they have been doing in the last few meetings, or whether they consider that the conditions have been filled for what they call a more forceful move, i.e.
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a move by 50 basis points.
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And if we look around the world, we've seen central banks moving in larger increments.
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Of course, the Fed's done 75%.
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The ECB opened its tightening cycle with 50 basis points.
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So I guess the risks are that the BOE does opt for a bigger move and go with 50 as well.
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So, Liz, let's turn to politics.
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The race is on for a Boris Johnson successor.
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Where are we in that process now?
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So Conservative MPs voted this week for the final two candidates.
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So the shortlist is down to two.
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That's former Chancellor Rishi Sunak and the current Foreign Secretary Liz Truss.
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Now that moves now to the Conservative Party membership, who will do a postal vote to decide which of those will become our next Prime Minister.
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And the result for that will be announced on the 5th of September.
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Now, there seems to be a lot of focus on the economy in this race.
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Is there actually much of a difference in terms of what the candidates are proposing?
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There is, actually.
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So Liz Truss is saying she wants to help with the cost of living by cutting taxes.
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She wants to reverse the national insurance hike that we had last April.
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She wants to cancel a planned tax hike on corporation tax coming next April.
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And she also wants to get rid of the green energy levy
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paid by households.
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Now, Rishi Sunak says, actually, cutting taxes is the wrong thing to do at the moment.
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That will only stoke demand, push inflation higher, potentially push interest rates higher still, and ends up prolonging the problem.
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So it's a live debate.
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I think we'll be hearing lots more on over the coming weeks.
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But at the moment, it's Liz Truss that seems to be appealing more to the voters, the Conservative Party members who will decide which one of them becomes prime minister.
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The polls of those members suggest that she's ahead and the betting odds also favour her.
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Interestingly, though, if we look at polls of the wider general public, i.e.
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outside of the Conservative Party, it looks as though Rishi Sunak might be more likely to win an election, beat the Labour Party than Ms Trust.
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So it'll be very interesting to watch over the coming weeks.
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Liz, you've talked us through a lot.
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Thank you so much for the updates.
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Thank you.
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So that's our view on the UK and the European landscape in this edition.
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Many thanks again to Fabio Balboni and Liz Martins for making themselves available during such a busy week here at HSBC Global Research.
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We'll be back next week.
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Thank you for joining us at HSBC Global Viewpoint.
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We hope you enjoyed the discussion.
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